Small Business Formation Basics - Tax Considerations

Most small business owners wonder what they can do to decrease their taxes.  The best answer for all small business owners is simple:  Focus on growing revenue and you will find taxes will not matter. Following this philosophy is all the more important for start-ups. In the first five years of business, growth can fix most issues. Growth, not decreased taxes, is the lifeblood of your business.

Regardless, it is important to discuss tax issues when forming a business.  When you form a business in Pennsylvania, you have several options.  The most basic form of business in PA is the sole proprietorship. The IRS treats sole proprietorships as a disregarded entity. If you’re unfamiliar with the legal jargon, you may ask “a what entity?”  A disregarded entity is one where the owner files both business taxes and their self-employment taxes on the same return. For most, this is the easiest option for running their business since there is less formality and government entanglement.

The complexity changes when it comes to corporations. Forming a corporation is the most secure option for small business owners looking to limit lawsuit losses at a personal level. Why?  Because with a corporation, the company owns the assets and services that might be subject to a suit – not the board, managers, or individuals like the sole proprietorship. Corporate liability, while important, is a topic for another day. 

So, what about the taxes on a corporation? In this business form there are two levels of taxation. The first is at the corporate level. Here the company pays 21% tax on its profits. The second level is for business owners and investors. These individuals are subject to income taxes on their salaries. Investors are subject to taxes on any dividends and a capital gains tax if they sell shares. So, while it has its place, a corporation is often not ideal for start-ups because of the tax complexities and corporate formalities. 

Now is an appropriate time to discuss S-Corps. A lot of questions and requests focus on S-Corps. An S-Corp is not a business structure; it is a tax election. It will come up in our next corporate entity discussion - the LLC.

From a legal standpoint, a limited liability company or LLC is a newer business structure. An LLC provides much of the same protection from liability as a corporation without the formalities. It also gives its members a couple of different tax options. This is where the S-Corp election comes into play. Whether a single member or multi member, an LLC is a disregarded entity. At formation the IRS treats it as a sole proprietorship or a partnership for tax purposes. In many instances, this works best. Those concerned with taxes have the option to elect to be taxed as an S-Corp. The difference in choice determines how the members pay themselves.

If the members elect taxation as an S-Corp, they will have to follow certain tax rules. The LLC may only have one class of stock, may not have more the 100 owners, and cannot have outside corporate owners.  Members are also required to take a reasonable salary, subject to all standard taxes. Members can make distributions that are not subject to self-employment taxes. The catch is that the IRS has never provided any insight about what is “reasonable”. This could mean more costs for accountants and lawyers to pay less taxes. 

At The Skeen Firm, we are passionate about small business growth and are here to help all small businesses achieve their goals.  Let us help you choose the right tax election for your situation, so you can focus on growing your business!  Contact us by phone at 724-550-6970 or by email at info@theskeenfirm.com to schedule your free consultation today.

*Disclaimer: the advice provided is for informational purposes and is not intended as legal advice.  It should not be relied on, nor construed as creating an attorney-client relationship.

Probate and Taxes and Fees, oh my!

Picture this for a brief second. We are all mid movie and a beloved character has tragically passed. What happens next? Everyone knows the answer. The family goes to some unknown attorney’s office to “read the will”. They all act surprised and furious when they are cut out of the decedent’s estate, the bulk of which went to charity and a beloved tabby. But is this an accurate construct in the real world? Keep reading for an explanation of why this is all Hollywood drama. Do not confuse this with meaning there might not be drama in what is better known as the probate process, but this is a preview of what to expect when a loved one dies. 

The scene described above in some ways describes an estate set up by a Trust. Those who die with an estate plan based on a will (testate in the legal world) are required to go through a process known as probating the will. For lack of better terms, filing a will with Register of Wills and petition for probate with the Orphans’ Court opens an action against the decedents’ estate so that their debts can be settled and remaining assets disbursed. Upon filing the petition, the court will grant Letters Testamentary enabling the listed executor/executrix within the will to begin gathering assets and acting on behalf of the estate.  At this point a whole list of beneficiaries, creditors, heirs, and even the public are given notice by the executor that probate is underway. 

After clearing these initial hurdles, the executor/executrix will focus on valuing all estate assets for a basis from which to settle debts and pay taxes. Tax situations vary by estate, but most can plan on paying a PA inheritance tax for any transfer that is not between spouses or children under 21. Federal inheritance taxes are more difficult to pin down because they change periodically based on the party in control. There are ways to plan for these changes, should an estate value project out that high. This is one of many reasons to develop a plan that can change to meet your needs as these changes occur. Once the assets are valued and both creditors and taxes are paid, the executor/executrix can prepare a final accounting and distribute the estate. 

Sure a will costs less up front than some other estate planning methods, it might cost the family more in the end through taxes and attorney fees. These fees vary from .5% to 7% based on estate size. Also, worth consideration is the emotional toll the probate process will have on some. Trusts offer a viable alternative but cost significantly more to establish.  They do, in many cases, avoid the probate process all together. One thing is certain; neither provides a way to completely avoid estate taxes. At The Skeen Firm we are ready to help you decide which plan makes sense for your situation and provide custom tailored solutions. Contact us today at 724-550-6970 or info@theskeenfirm.com to get started on your plan!

*Disclaimer: the advice provided is for informational purposes and is not intended as legal advice.  It should not be relied on, nor construed as creating an attorney-client relationship.